How much debt is okay?
Some argue that any debt is too much. Others say that you should have only good debt (for investing) and no bad debt (for spending). In reality though, debt is simply a financial tool that you should use wisely to avoid getting in over your head.
There are several measures you can use to determine whether you’re carrying too much debt. One we rely on is known as the total debt service (TDS) ratio. As a general guideline, no more than 40% of your monthly gross income should go towards mortgage loan payments and other monthly debt obligations.
Realistically, the amount of credit you can afford depends on your personal situation. If your current employment is not secure, you will probably want to take on less credit than the recommended guidelines. On the other hand, if you have no other obligations, such as a mortgage, and your source of income is reliable, you may want to take on more credit, depending on your goals.
The right credit level for you
In any case, you should borrow only enough money to make the purchase you have planned, rather than borrow as much as you can get:
- decide on your short- and long-term financial goals
- calculate your average monthly income and expenses (including all the bills and debt you're currently paying)
- establish a saving and spending plan
The right amount to borrow
To find out whether can afford to repay a loan, take the difference between your income and your expenses. This is your discretionary income. From this amount, you'll need to first deduct your minimum monthly savings. It's a good idea to also deduct additional savings to help you meet some of your financial goals. These might include buying a house or a new car or building an emergency fund.
What's left over defines how much new credit you can afford to take on. If you're only just meeting your monthly bills, an unexpected expense could mean a serious financial setback.
If you are already paying off debt, which should be included in your expense summary, you may not be in a position to use additional credit until your existing obligations are repaid.
To find out how much you can safely borrow, try our Loan Calculator.